In the fourth quarter, international equity markets finished the year on an upward note despite a stronger U.S. dollar providing headwinds. The S&P Developed Ex-U.S. BMI delivered a 2.3% return in U.S. dollar terms for the quarter. Most major markets posted low single-digit positive returns as investors marked up lower quality winning positions for the year. The U.S. equity market experienced another positive quarter, particularly among smaller cap growth stocks as the Russell 2000 Growth index rose 4%. 

2009 was a banner year for global equity markets, driven by unprecedented global stimulus and economic recovery. Investor perceptions, behaviors and, therefore, market results were the inverse of 2008. According to index provider MSCI, 45 of 49 equity markets rose last year with the majority posting positive returns in excess of 40%. The run in emerging markets was even stronger, with the S&P Emerging index delivering an astounding 84% return and outperforming the S&P Developed Ex-U.S. BMI by over 40%! This is the single biggest spread in the history of the two indexes by a wide margin. 

Underlying these enormous absolute numbers are some disturbing trends that give us concern about the current health of the overall market. In a "normal" market, firms that do well will see their stock prices rise, while the stocks of weakening companies will decline. However, in 2009, the stocks of efficiently run companies whose business were growing, had lower debt, and were beating expectations fared worse than companies who exhibited poor fundamental characteristics -- stocks of the losers beat those of the winners. In fact, among international companies, 2009 was the best year for high volatility stocks in the last 20 years, surpassing both the internet bubble of 1999 and the low quality rally of 2003. 

For an investor with a fundamentally driven process, it was disheartening to watch "junk" stocks outpace quality stocks month after month. This tells us that the market is mainly just responding to the effectiveness of the efforts of central banks and governments to reinflate the world economy. While indiscriminately raising demand and propping up inefficient businesses may have staved off a depression, it is not a sign of a healthy economic recovery or a "normal" equity market. 

Historically, low quality rallies are both fleeting and unsustainable - you may recall how the high beta effect reversed itself following particularly robust outperformance in 1999 and 2003. We continue to see mounting evidence that a change in market leadership is occurring, and we are confident that the year 2010 will better reward higher quality companies.